Friday, 18 December 2015

By Michael Burke
The US central bank the Federal Reserve has raised interest rates for the first time since 2006. The Fed began cutting interest rates in 2008 in response to the Great Recession and the associated financial crisis. On the face of it the timing appears odd, as the US economy has not experienced any robust recovery since the crisis. 2010 was the strongest annual growth rate at 2.5%, which is an extraordinarily tepid rebound from such a sharp recession.

More recently industrial production has gone back into recession, as shown in Fig. 1 below. Output has fallen for 4 straight months and is 1.2% below its level a year ago in November 2014. Although this is depressed by the fall in energy output, manufacturing as whole is barely stronger, rising just 1% from a year ago.

Fig.1 US Industrial Production In Recession

An economic slowdown and falling output might not seem the most appropriate time to raise the level of interest rates. But the level of Fed Funds is not correlated to the growth of industrial production at all, and has frequently moved in the opposition direction to the growth in output as shown in Fig.2 below.

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The Fed has entirely different goals in raising rates in the current period, although it will have to monitor closely the pace of the slowdown. The goal of the Fed is to bolster the attractiveness of the US economy to capital inflows, and within that strengthen the already dominant role of the banks.

One of the features of the current crisis is a widespread mystification of the role of credit and money in the economy. Interest rates are the price of credit, what is charged by the lender to the borrower. A key difficultly for banks in particular arises when interest rates are at or close to zero. If the price of credit generally available is close to zero and is readily available banks will find it extremely difficult to make profits. They will substitute lending for increasingly speculative activity, gambling in the stock markets, in housing, in commodities and so on.

However, there is a central misconception in the Fed’s efforts to ‘normalise’ the interest rate environment and it is a risky strategy. The idea is that raising interest rates will prompt a shift away from speculation towards productive lending for investment. But in aggregate US companies have little need to borrow for investment. This is because their own investment remains lacklustre and so can be funded well within their own resources, that is profits. Fig. 3 below illustrates this point by showing the nominal level of US GDP, company profits (Gross Operating Surplus) and investment (Gross Fixed Capital Formation).

Fig.3 GDP, Profits and Investment

From 2000 US GDP has expanded by $7.1 trillion. Profits have risen by $3.3 trillion and yet investment has only risen by $1 trillion. In the period from 2000 to 2014 the profit share of US companies has risen from 37.5% of GDP to 41.2%. At the same time the proportion of GDP devoted to investment has fallen from 23% to 19.5%.

If we take the measure of the investment rate as the proportion of profits devoted to investment, this has fallen from over 60% to little more than 47% over the period. As a result, firms can access their own funds in order to finance productive investment. Yet, as already noted, investment is a declining proportion of US GDP.

Instead, the most likely outcome of higher interest rates is likely to be increased charges to consumers, in the form of credit card debt, auto loans, mortgages and so on. This will effectively be a transfer of incomes from consumers to banks.

On a global scale the effect is likely to be much worse. As the US Dollar is the sole world reserve currency all international debtors are obliged to borrow in US Dollars. For commodity producers, whose exports are priced in US Dollars the further fall in commodities’ prices reduces national incomes and tends to cause both currency depreciation and capital flight.

Capital tends to flow towards the US with higher rates. Outside the industrialised countries the so-called ‘emerging markets’ are expected to have seen their first net outflow of capital in 27 years in 2015. For individual countries such as Brazil, Turkey, South Africa and many more the effect of capital flight can be dire.

But there is also a negative impact on the world economy as a whole. Capital flows to the US are to a low investment-high consumption economy. Sucking in capital from the rest of the world to finance US consumption – and bank interest on financing it - will have the effect of slowing world growth even further. It is a high-risk strategy from the Fed, one in which the US is unlikely to be the main casualty.

Monday, 30 November 2015

The following piece was originally a presentation to the recent conference of the Labour Assembly Against Austerity. Prof. Chick is one of the foremost Keynesian economists in Britain.

The argument below may surprise many who regard themselves as ‘Keynesians’ and yet who argue for persistent budget deficits and routinely borrowing to support consumption.

On the contrary, a key point of agreement between Marxists, genuine Keynesians and others, and one that is reflected in the editorial line of SEB, is that investment is decisive for economic growth and that the current crisis is caused by the weakness of investment.

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By Victoria Chick

Since the election of Jeremy Corbyn as leader it has become acceptable in the Labour party to challenge the austerity doctrine (Corbyn The Economy in 2020). What a welcome change! Rational economics starts here.

I shall take it as read that everyone in this room holds the following truths to be self-evident:

(1) That austerity is counterproductive if its purpose is to reduce the public debt and

(2) That its real purpose is to provide a smoke-screen behind which to shrink the state and reward the rich

There is another truth that is less obvious:

That government cannot determine the size of its deficit by its own actions.

Austerity is not only unpleasant politics; it is bad economics. We need to explain and communicate this fact to the electorate -to demonstrate that we are not the ones who are economically illiterate!

The economics of austerity is based on an inappropriate generalisation from the individual’s budget to the government’s budget. Mr Micawber can control his deficit, but only because he is a small cog in a great machine. Government is a big component of the machine, and other parts react to what it does. Those reactions influence national income, the level of unemployment (and hence benefits) and tax revenue. A cut in expenditure will reduce income by more than the original change in government expenditure (the multiplier, working negatively).

Second, there is the ‘three balances’ identity: (G-T) + (I-S) = M-X
[where G is total Government spending, T is Government revenues, I is investment, S is savings, M is imports and X is exports].

The private sector is just about in balance; the fiscal deficit is almost the mirror image of the international current account deficit. The fiscal deficit cannot be eliminated (should you want to) without eliminating also the international deficit, which almost no-one is talking about (John Mills is an exception).

Alternatives to austerity

If you really want to eliminate the deficit, the positive response of the economy to government action, the multiplier in the positive direction, needs to be enlisted. In a recent blog, the TUC’s senior economist, Geoff Tily, recalled that Keynes, who was the first to exploit the potential of the multiplier, did not use the phrase ‘deficit spending’ which is so closely associated with his name but rather ‘loan expenditure’. Now since deficits have to be financed by borrowing you might not see any distinction, but the point is that wise, productive loan expenditure pays for itself over time and increases the productivity of the economy. Output and employment rise, the tax take rises, benefit costs fall and we have increased our productive and social capital. Loan expenditure reduces the deficit as the economy recovers. The point is rhetorical, but it is good rhetoric that we need.

Keynes on the budget

Let us look more closely at Keynes’s view of budgetary policy, for it is usually much mis-represented and current discussion of the budget in normal times is still somewhat confused. He distinguished between the ‘ordinary budget’ or current account, and the capital budget or spending ‘below the line’ – a distinction we make today.. The latter was to be used to compensate for failings in private-sector investment.

‘...periods of deficiency (sic) expenditure should be made the occasion of capital development until our economy is much more saturated with capital goods than it is at present.’ (J M Keynes, Collected Writings vol XXVII p 320)

This would by itself make the economy more stable:

‘...if the bulk of investment is under public or semi-public control and we go in for a stable long-term programme, serious fluctuations are enormously less likely to occur.’ Ibid. p 326

By contrast the aim should be for the current budget normally to run a surplus,

In other words, deficit financing is for emergencies only – emergencies like the depth of a depression. That lesson was learned and applied after the financial crisis. There is no need to follow the financial crisis with a self-inflicted fiscal crisis. The economy is currently far from peachy but it is not in dire straits. Let us not plunge it into further recession by austerity. Worse, this and the previous government have gone about things in precisely the wrong way, cutting investment rather than current expenditure. Let us instead keep calm and debate where the capital budget should be directed. Intelligent capital spending is more likely to reduce the deficit than austerity.

What kind of capital spending?

As anyone who has read Michael Meacher’s last book knows, there is no shortage of useful things to do. Everyone will have his or her priorities here; but there are some very obvious candidates: green infrastructure, housing. In general, real investment, including investment in those things whose return is hard to measure (education, health, even some infrastructure), and even in things that yield little or no financial return. On this latter point, there is a tremendous PR job to be done, for the mindset is as wrong-headed today as it was in Keynes’s time. He wrote:

‘The nineteenth century carried to extravagant lengths the criterion of what one can call for short "the financial results," as a test of the advisability of any course of action sponsored by private or by collective action. The whole conduct of life was made into a sort of parody of an accountant's nightmare. … I spend my time … in trying to persuade my countrymen that the nation as a whole will assuredly be richer if unemployed men and machines are used to build much needed houses than if they are supported in idleness. …

The same rule of self-destructive financial calculation governs every walk of life. We destroy the beauty of the countryside because the unappropriated splendours of nature have no economic value. We are capable of shutting off the sun and the stars because they do not pay a dividend.’ ‘National self-sufficiency’, The Yale Review, Vol. 22, no. 4 (June 1933), pp. 755-769_

We must face down that dreadful sneer, that government is no good at ‘picking winners’. Is the private sector so good at ‘picking winners’? The banks, for example? Private investment now has virtually dried up, in favour of at best unproductive and at worst pernicious financial speculation. The incentives for private share-holder-owned companies in any case favour far too short a time horizon. As Mariana Mazzucato argues, government’s role is to create and foster markets, not just to rectify their malfunction. That means a courageous state must not flinch; it must be prepared to ‘pick’ what in its best judgement will be winners but knowing that some will be losers – to use the power of its budget to change the direction of our economy to deal with the pressing problems that we face. The private sector will not do that. It wants to return to business as usual. Business as usual is not an option.

Wednesday, 25 November 2015

By Michael Burke
Having spectacularly failed in his stated goal of eliminating the deficit in the last parliament, George Osborne is repeating his experiment in this one. Both the June 2010 and 2015 Budgets proposed ‘fiscal tightening’ of £37 billion. In the first of these Budgets the main method was cuts in public spending. In the second it is the sole method.

In the latest Autumn Statement this now falls to £36 billion and takes place more slowly after the U-turn on implementing cuts to working tax credits. These are now effectively scheduled to take place more slowly under the guise of ‘reform’ to the Universal Credit system.

The effect of renewed austerity is reasonably predictable. The economy has not grown significantly in the last 5 years. As nominal GDP is approximately 16% higher, so the impact of almost exactly the same nominal cuts will be very similar as from 2010 onwards. Likewise, the starting-point for growth is about the same. In the 3rd quarter of 2010, ahead of that Comprehensive Spending Review the GDP growth rate was 2% and on an upward trajectory from the depth of the recession. In the recent preliminary estimate the growth rate in the 3rd quarter of this year was 2.3% and slowing from 3% following the election boost to the economy, as shown in Fig.1.

Fig.1 GDP Growth Since the Recession

The effect of the first round of austerity was to slow the economy to a crawl. Living standards fell and the deficit actually began to rise. GDP growth was 1% in both the 2nd and 4th quarters of 2012 and only lifted above that by the boost from the London Olympics. The economy is set to slow again in 2016 under the impact of austerity and based on past experience may slow towards 1% growth in 2017.

Policy Options

At the time of the March 2015 Budget there were blood-curdling forecasts of the decline of public spending to lower levels than the 1930s. This was entirely a political manoeuvre, a trap designed to get Labour to support unfeasible spending plans and so have nothing positive to offer in the election campaign, which Ed Balls duly jumped into.

In fact, it is the content of government current spending which matters far more than its proportion of GDP. Government spending on education, on health, on childcare and other public goods improves the living standards of the population. An increase in social security payments because of rising joblessness or in-work poverty is necessary but can only partially alleviate falling living standards. There is a world of a difference between current spending that falls because well-paid jobs are being created on a large scale, or falls because the NHS is being cut.

The medium-term history of the British economy is stable or rising Government current spending as a proportion of GDP, as shown in Fig.2. It is the composition of this spending which has adversely altered. To take just one well-known example, the public sector has almost given up on house-building but incurs £25 billion annually in housing benefit payments, which are paid to landlords – enough to build over 160,000 affordable homes. This reflects both slower growth and rising inequality.

Fig.2 Government Current Spending (lhs) & Net Investment (rhs) as a Proportion of GDP

The focus for cuts over the longer run has actually been to public sector net investment. This has been renewed by Osborne. The Blair/Brown government slashed public sector net investment to an all-time low (to meet other, extremely damaging Tory spending plans in 1997 to 2000). But Brown increased public sector net investment to 3.2% of GDP in response to the slump in 2008 and 2009 and this was responsible for the recovery. Osborne has effectively halved this rate of investment.

SEB has previously shown that the private sector followed suit in both cases; increasing or decreasing its own investment rate in response to the rise or fall in public sector investment, with a time lag of 6 months. This is a practical demonstration of what is meant by the phrase state-led investment.

These very different trends in the components of government spending reveal the truth behind the Tory rhetoric of ‘deficit-reduction’, ‘living within our means’ and ‘shrinking the state’. Successive governments, of which this is just the most brutal, have not reduced total current spending as a proportion of GDP and have been content to borrow to fund that spending. They have simply changed its content. Landlords and others, after all, are part of the class of capitalists in whose interests economic policy is formulated.

State spending has not shrunk, but state investment has been savaged. The trend is towards minimal or even zero net public investment. This is because investment creates the means of production. If the public sector invests it owns those means of production. They are not owned by business. To the extent that the state owns the means of production it can direct the level of investment in the economy and its overall trajectory. Private business cannot directly make profits from the means of production it does not own, which explains the contrary drive towards privatisation.

Corbyn & McDonnell are right

The response of the Labour leadership is therefore correct. Prior to Comprehensive Spending Review Shadow Chancellor John McDonnell said his approach could be summed up as “investment, investment, investment”. Firm opposition from the Labour leadership to cuts in working tax credits produced Osborne’s U-turn.

Investment (Gross Fixed Capital Formation) has been in a long-term downtrend in the British economy. It was also specifically responsible for both the recession and for the weakness of the recovery. The long-term investment downtrend is shown in Fig. 3 below, which shows both total investment and Government investment as a proportion of GDP.

Fig.3 Total Investment and Government Investment as proportion of GDP

The startling fact revealed by this chart is that it is the slump in Government investment which is primarily responsible for the decline in aggregate investment. Over the entire period the peak to trough decline in total investment has been 26% of GDP to 15% in the recession. The decline in the Government component of that is 7.5% to 0.5%. It is the cut to Government investment which is driving the long-term decline in British investment, responsible for 7% of a total decline of 11%.

As the chart also shows, the decline in investment in the current cycle began in 2006, long before either the financial crisis or the recession itself- and was led by a private sector decline. The rate of investment is decisive for the trajectory of the economy as a whole.

The policy focus must not be on investment in general, with exhortations or bribes to the private sector to invest. This has been tried by Osborne and failed. It must be direct investment by the public sector itself, in housing, transport, infrastructure, renewable energy and education. The private sector will follow.

This is why the proposed Public Investment Bank is so important, supported by measures such as PQE and changes to the tax system to penalise unearnt income such as shareholder dividends while promoting investment. The Public Investment Bank can mop up the idle cash of the large corporations, and direct it for productive investment. Crucially, it also allows the public sector to reap the benefits of that investment, so that it acquires a larger and enduring weight in the economy able to sustainably increase investment over the long-term.

Thursday, 12 November 2015

By Michael Burke
The Labour Assembly Against Austerity conference in London takes place this Saturday, November 14. The author is pleased to be able to share a platform with Ann Pettifor a direct of PRIME and author of ‘Just Money’ as well as Professor Victoria Chick whose major works include ‘The Theory of Monetary Policy’ and ‘Macroeconomics After Keynes’.

All the panellists (and probably the audience) are opposed to austerity, and the debate is within that context. The opponents of austerity all want an alternative to this policy and to raise living standards. The debate turns on how this can be done.

As SEB has previously shown there are only two uses of output; either investment or consumption. A sustained increase in living standards requires an increase in output. Increased consumption is a consequence of increased output. The question then becomes, can living standards be increased by increasing the rate of consumption, or is it necessary to increase the rate of investment?

The answer to this question provides the fundamental basis of economic policy, and not simply fiscal policy. If Consumption ‘C’ is the fundamental driver of growth over the medium-term then all available economic levers should be used in order promote it, monetary, fiscal, regulatory and so on. The converse is true if Investment ‘I’ is the fundamental driver of growth.

The recent history of the British economy is instructive in resolving this question. After a bout of austerity followed by a pre-election boost to demand in the last parliament living standards effectively stagnated, measured as per capita GDP. As this measure is an average it disguises the transfer of income from poor to rich and from labour to business that the austerity policy entails. Most people are actually worse off than 5 years ago.

The chart below shows the key developments in the level of GDP and its composition in the period since the recession began in the 1st quarter of 2008 to the 2nd quarter of 2015.

Fig.1 Change in GDP & Components Since Recession Began

The recovery has been exceptionally weak by historical standards. Even so, real GDP has increased by just under £100bn since the recession began in 2008, an increase of just 5.9% in more than 7 years! Consumption (including both household and government consumption) has risen by more than £80bn over the same period, an increase of 5.6%. By far the weakest component of GDP has been investment, which has risen by less than £5bn, or 1.6%. Given the time period, in statistical terms this is effectively zero growth of investment. (The residual, the difference between GDP and C and I combined of £15bn is accounted for by net exports, inventories and other items).

Osborne has not ‘rebalanced’ the economy, but has tilted further in the direction of consumption and away from investment. This matters because only investment (and education) can increase the means of production. Consumption cannot do that.

If it were true (in some sort of inversion of Say’s Law) that consumption creates its own investment, then we should have expected investment to rise at least in line with consumption over the ‘recovery’ period. But prior to the recession the ratios of GDP to consumption and investment were approximately 7:6:1. In the recovery period the ratios have been changed to 20:18:1.

The rate of consumption has risen and the rate of investment has fallen. But the mass of the population is not better off. This is because investment is required to sustain growth, which is the basis for rising living standards.

It may be argued that the rise in consumption is insufficiently strong to spur an increase in investment, and that much stronger growth in consumption would produce more investment by reducing spare capacity. But there is no evidence for this assertion. As profit-maximisation is the goal for producers, it is just as likely in the current period that producers would meet capacity-straining increases in consumption with higher prices.

In fact the entire crisis is characterised by what Keynes dubbed ‘liquidity preference’ and Marx called the hoarding of capital. Firms are investing a low and declining proportion of their profits. More revenues from consumption and more profits are not leading to a revival of investment.

It is a false notion that it is possible to increase living standards over the long-run by prioritising the growth of consumption. The sustained growth of production requires the growth in the means of production, which requires investment. It is only in this way that that is possible to sustainably raise living standards.

Friday, 6 November 2015

The Labour Assembly Against Austerity meeting on November 14 is an excellent opportunity to discuss the key economic issues, promote the anti-austerity policies of the Labour leadership and debate the way forward.

The Labour Party and the left in Britain generally has never before been in a situation where its leadership has been under such sustained and ferocious attack from its opponents. This is because Labour’s new leadership is also something entirely new. It espouses policies which run counter to the austerity offensive, which is the main project of big business and its political representatives. So bringing together all those who want to defend this leadership against right-wing attack, discussing the alternatives to austerity and debating the way forward is vital.

The keynote speaker is the Shadow Chancellor John McDonnell. Along with Jeremy Corbyn and their allies, he has pushed the Tories back on cuts to working tax credits, so much so that it would now be a surprise if at least some concessions were not made. But it should be clear that any gains made through amendments to Osborne’s plans and the Tories’ political difficulties arise because there has been such firm and clear opposition from Labour.

Even if there are certain tactical retreats, it is also clear that the Tories will be relentless in their pursuit of austerity policies. There is no significant section of big business opinion which does not support austerity. Therefore it will be increasingly important for the entire anti-austerity movement and the Labour Party to clarify its economic alternatives and to popularise them among the widest possible layers in society. The debates should be about how to defeat the Tories and their austerity policy, and what the sustainable alternatives should be. As such, the debates will need to be comradely ones aiming to maximise light while minimising heat.

In Britain and in many Western economies in the period since World War II there has been a bastardisation and then the almost complete marginalisation of advanced economic thought. The most important economists are reduced to fortune cookie phrases in the case of Adam Smith’s ‘invisible hand’, completely distorted with reference to Keynes’ ‘digging holes and filling them’ or ignored completely in the case of Marx. Building a movement that is capable of challenging and then defeating the Tory arguments will require a culture of debate and familiarity with these authors and more besides.

SEB has shown that growth is required to raise living standards and that growth itself is primarily determined by the rate of investment. It is because the rate of investment is so low in the British economy that there has been no growth in living standards since the crisis began. The economy has expanded by just £100bn from the 1st quarter of 2008 to the 2nd quarter of 2015, less than 6% in over 7 years. But of this growth £80bn has been the growth of consumption while just £4bn has been a rise in investment. We remain in an investment crisis.

The Labour Assembly Against Austerity meeting will offer the opportunity to hear from leading figures in the Labour Party, the trade unions, campaign organisations and the anti-austerity movement. A series of workshops will allow more detailed debate. Both of these are necessary if the movement as a whole is to continue its momentum and build a clear understanding of the alternative to austerity.

Sessions on:
Labour's alternative to austerity
Corbynomics: raising growth and improving living standards
Free public services, decent wages and unions for all
Tackling the housing crisis – building council houses & controlling rents
Who should pay for the crisis? - tax justice not benefit cuts
Ending austerity, building the movement and winning for Labour
Oppose racist scapegoating – refugees and migrants are not to blame
Invest in people and the planet not war

Thursday, 29 October 2015

By Michael Burke
The British economy is slowing down. In the 3rd quarter of 2015 the economy had expanded by just 2.3% from the same period in 2014. This measure removes the volatility of erratic quarter to quarter movements in GDP.

The most rapid pace of growth in this recovery has been the 3.1% recorded in the 2nd quarter of 2014, which mainly reflected government efforts to stoke consumption (particularly in housing) in the run-up to the election. Since that time the growth rate has progressively slowed. This is shown in Fig.1 below. Despite the severity of the recession, at no point has the growth rate matched the higher levels seen before 2008 to 2009.

Fig.1 UK GDP- Growth is slowing

The slowdown does not mean that a recession is imminent, although this business cycle will come to an end at some point and the global economy is also experiencing some difficulties. The more immediate danger is the effect of government policy and the renewed imposition of austerity policies.

As SEB has previously shown, Austerity Mark II announced in the July 2015 Budget is exactly the same as Austerity Mark I announced in June 2010, a fiscal tightening of £37 billion in both cases. The real effect will be somewhat less this time as the economy has expanded moderately in the interim. Even so, the effect of the first round of austerity was to slow the economic growth rate from a little over 2% year-on-year to 1%. A similar outcome should be expected this time around.

Examining the slowdown

This weakening outlook is the increasing subject of commentary. An article in the Guardian by David Graeber has received a lot of attention. He is a committed opponent of austerity, and all disagreements should always be read in that context. In ‘Britain is heading for another crash: here’s why’ he correctly castigates George Osborne’s economic fallacies, but then supplies a few of his own. As these appear to be widely shared by other progressive economists and opponents of austerity, they are worth debunking.

Graeber argues that any government surplus must entail a private sector deficit. As he correctly states, this is simply an accounting identity and must be true; every borrower requires a saver and vice versa. He goes on to say that the determination to run public sector surpluses is necessarily negative, as it forces the private sector to borrow. He further states that this debt is forced on to those least able to pay it and that this causes recessions, which is often the case.

But in this key passage (using the chart he supplies) he adds, “But if you push all the debt on to those least able to pay, something does eventually have to give. There were three times in recent decades when the government ran a surplus:

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Note how each surplus is followed, within a certain number of years, by an equal and opposite recession.”

Note the reason why the surpluses of the private sector do not cause recessions is never explained, nor why we might be entering another recession even though there are still large government deficits.

There are in fact four separate episodes of fiscal surpluses in Britain shown in the chart. Examining them debunks the fallacy that government surpluses cause recessions. The chart used shows the largest surplus of all on the overall fiscal balance in 1948. There was no recession at all until 1974! At the end of the 1960s there was modest surplus, followed by 5 years of continuous growth, and the largest-ever growth rate recorded in a single year, 6.5% real GDP in 1973. The small surplus in 2000 was a result of New Labour sticking to extreme Tory spending plans in the first two years after election in 1997, which was subsequently relaxed. Reasonably strong growth (in British terms) followed and the subsequent crash 8 years later had nothing to do with that surplus. The surplus in the late 1980s was a function of the glut of North Sea oil. This should in fact have been larger, had Government saved this windfall for future investment, as Norway did. Instead, along with Government borrowing it was used to stoke a consumption surge, the ‘Lawson Boom’. The subsequent recession occurred when boom turned to bust. The surplus did not cause the recession – borrowing for consumption while also floating in oil revenues caused an unsustainable boom that inevitably failed.

This argument for permanent fiscal deficits makes no distinction at all between borrowing for investment and borrowing for consumption. The long-run history of the British economy and its decline is in part characterised by the rising rate of Government consumption coupled with a falling rate of Government net investment.

Fig.3 below shows that the strongest rate of growth of GDP in the 1960s was associated with the lowest levels of Government current spending, and vice versa. The higher rates of Government consumption are associated with the slowest levels of growth. The long-term trends are also clear; rising Government spending and declining rates of GDP growth.

Fig.3 UK Public Sector Current Spending Rises As GDP Growth Declines

By contrast, high or rising rates of public sector net investment are associated with high or rising rates of GDP growth (again, in British, not global terms). This is shown in Fig.4 below with public sector net investment as a proportion of GDP alongside the rate of growth of GDP.

Fig.4 UK Public Sector Net Investment, % GDP & GDP Growth

Here, although the GDP data is erratic the relationship clearly trends in the opposite direction; as net investment declines so does the GDP growth rate, and vice versa.

In fact there is a significant negative correlation between public sector current spending and GDP growth of -0.41326. By contrast, there is a very small positive correlation between public sector net investment and GDP growth of 0.1281, which rises to 0.21235 if GDP growth is lagged for 3 years (possibly to account for the economic effects of large projects). But in an economy like Britain’s, public sector net investment is usually too small to determine the overall rate of economic growth.

Fig.5 below shows the rate of GDP growth alongside the proportion of total investment (Gross Fixed Capital Formation) in GDP from both the public and private sectors. Even a cursory glance shows the strength of this relationship and the correlation is 0.7721. It is investment which is the primary driver of growth.

Fig. 5 GDP Growth & GFCF as a Proportion of GDP

The proportion of GDP devoted to investment (GFCF) is the main determinant of the growth of GDP. But currently the level of public sector net investment is too small to affect the outcome of GDP. At the same time, the level of private sector investment is too weak to support a more robust economic recovery. What can be done?

‘Crowding out’ and Corbynomics

One of the greatest fallacies in modern economics is the notion of ‘crowding out’. This is the assertion that if a level of public sector investment or borrowing is too high then this will prevent the private sector from investing. It particularly came into vogue during the era of privatisations under Reagan and Thatcher and is inscribed in most Western econometric models.

It is a nonsense because it assumes a fixed or steady state economy. But if either the public or the private sector invests in the productive economy, there will be economic growth and so increased funds available for investment.

Over many decades the Western economies have provided ample evidence that the notion of ‘crowding out’ has little basis in fact. Fig. 6 below shows that over the medium-term UK public sector net investment as a proportion of GDP has been cut. In common with most Western economies, the total level of investment as a proportion of GDP has not risen but has actually fallen, although the British case is one of the more extreme examples of both.

Fig.6 GFCF as a proportion of GDP & Public sector net investment as a proportion of GDP

It is clear from the chart that public sector net investment leads investment overall. There is a lagged effect, so that the strongest effect of rising public investment on total investment is registered 5 years later. On this basis the correlation between the two variables rises to 0.6820. Far from public sector investment ‘crowding out’ private sector investment, high and/or rising public sector investment ‘crowds’ it in.

This in turn is a significant part of the answer to the question posed earlier, what is to be done if investment is the main determinant of economic growth, yet public sector net investment is currently too small to effect the outcome of GDP as a whole?

The austerity policy is in part a failed answer to this question. It assumes that if wages and taxes on business are pushed down, businesses will increase the proportion of their profits assigned to investment. This has not occurred.

By contrast, Corbynomics has a very different answer. As high or rising public sector investment crowds in private sector investment, the policy response should be to raise the level of public sector investment in order to raise the total level of investment in the economy. The purpose is to raise the sustainable growth rate of the economy and so improve living standards.

If there are future crises of private sector investment, it may be necessary to raise the level of public sector investment once more. But the answer to the current crisis is to increase public sector net investment to a level where total investment is sufficient to sustain much higher, more sustainable growth.

Currently, the level of investment as a proportion of GDP is 20.6% in the OECD as a whole. In Britain it is 16.9%. An immediate objective should be to raise British levels of investment towards that average, so that competitiveness is not further eroded and living standards do not fall further behind. That is the first step towards addressing the current crisis. Future steps will be discussed in subsequent pieces.

Friday, 23 October 2015

The debate on what spurs economic growth and therefore what policy tools to use is not unique to Britain. As the world economy slows, variations on this debate are taking place in many countries.

A piece on the Irish blog ‘UNITE’s Notes on the Front’ deals with this question from the specific perspective of the current Irish economic and political situation and is written by Michael Burke.

The context is that the general election to the Irish Dáil is less than 12 months away. The current government is a coalition led by the right wing Fine Gael and the Labour Party and has been pursuing austerity policies. But now that an election is in the offing the Coalition has shifted towards boosting consumption in order to get re-elected (much like the coalition government in Britain after 2012). This was the content of the recently announced Budget for 2016.

However, a wide array of forces opposes this agenda. Sinn Féin, some other elected representatives, many in the trade unions and social justice campaigners all argue (with differing emphases) that investment should take precedence. Boosting consumption should be a secondary priority and this should mainly be done by boosting the incomes of the poor and lower paid workers at the expense of the rich and the very highly paid.

There are sound theoretical reasons for this order of priorities, which have been demonstrated by SEB. Moreover, the recent history of the US, which is the Western economic model shows that, as consumption rises as a proportion of GDP economic growth slows and so does the growth rate of consumption. An examination of recent Irish economic history exhibits the same pattern. This is, a high or rising proportion of the economy devoted to investment leads to higher growth, including the growth rate of consumption. A low or falling proportion of investment leads to slower growth, including the growth rate of consumption.

Thursday, 15 October 2015

Economic policy is central to the survival and eventual victory of the new Labour leadership, even though it is clearly not the only issue. Contrary to the usual Tory media reports, Jeremy Corbyn and his Shadow Chancellor John McDonnell registered an advance with the debate and vote on Osborne’s risible Fiscal Responsibility Charter. That advance came because the correct position of voting against was adopted. As this question will not go away, further advances will require even greater clarity.

The measure of the advance can be summed up in its political aspect with an analysis of the vote. Just 20 Labour MPs rebelled against Labour’s line by abstaining on the Charter. It may be recalled that of the 35 nominations Jeremy Corbyn received from MPs in the leadership contest, only about half of them actually supported him. During that campaign the vast majority of MPs followed the line of abstaining on the Tories massive cuts in the Welfare Bill. Now the overwhelming bulk of the Parliamentary Labour Party has voted against the key Tory legislation of permanently enshrining austerity and ruling out borrowing for investment. This is despite the fact that as recently as May the party’s economic line was ‘fiscal rectitude’, ‘zero-based spending reviews’ and sticking to outlandish Tory spending cuts in the first two years of the Parliament (something the Tories could not do in their own June 2015 Budget).

Politically, the 20 abstainers have isolated themselves within the party (although they will no doubt find regular berths in the BBC studios and lots of column inches in the Murdoch press). Jeremy Corbyn and John McDonnell have led the PLP to a much better economic position by opposing Tory economic policies. As the Tories are committed to austerity and this will be central to the economic debate over the next five years, that leadership will need to keep moving forward.

Exposing Osborne’s fallacies

Labour lost the last election because its economic policies were not credible. There is a concerted effort to distort this factual finding to suggest that Labour was too anti-austerity. Therefore the debate on economic policy is central both to the future direction of Labour policy and its election prospects.

Osborne’s great fallacies, like most distortions of the truth, have some connection to popular understanding otherwise it would be impossible to explain their political power. A central fallacy is to treat all debt as essentially the same, with equally negative consequences. Instead, as Socialist Economic Bulletin (SEB) has repeatedly shown John McDonnell and Jeremy Corbyn have made the correct distinction between borrowing for consumption and borrowing for investment.

In the homely analogies beloved by this Chancellor and by Margaret Thatcher, ordinary households understand very well the difference between different types of borrowing. Borrowing to buy a home, or borrowing to pay for night classes, or a new work-related computer all provide an asset or additional income and so are an investment. But borrowing to pay the electricity or grocery bills is not sustainable. It may ‘circulate more money in the economy’ but can only be done in extremis and not in the long-term.

Likewise, businesses understand cashflow. Business makes an appraisal of investment opportunity on the basis of cost-benefit analysis. If a reasonable expected rate of return exceeds the cost of borrowing then the investment will be made. But if the business is borrowing to meet day to day expenses it will soon face insolvency and possibly bankruptcy.

Government relies on these economic agents for its income. But in truth it is not unique as all three agents, government, business and households rely on each other for their income both directly and indirectly. In that sense government is no different. Government borrowing for investment delivers an economic return, either direct or indirect, will expand the economy and, just like business a key criteria will be whether the rate of return on the investment exceeds the borrowing cost. Contrary to views Keynes did not hold, but which are misleadingly entitled ‘Keynesianism’, borrowing for day to day consumption will not necessarily expand the economy – this depends on whether extra production increases profit, and in a number of situations expansions of demand may not increase profit and may actually reduce it. Consumption should usually be met by current revenues from taxation. If there is a shortfall between desired government current spending and revenue, wasteful spending can be cut (e.g. Trident) and/or taxes can be increased.

SEB has repeatedly demonstrated that investment is the decisive input for growth and consumption cannot lead growth, and from this it follows that government borrowing should be used for investment over the business cycle (running deficits/borrowing for consumption as well as investment may of course be valuable in economic downturns)

Alliances

The clear opposition to the Fiscal Responsibility Charter from the ‘Corbyn/McDonnell’ team on the Labour front bench was supported by strong economic arguments from a number of quarters, not all of them long-standing allies.

In the Commons debate Caroline Lucas said, “The Chancellor is incredibly irresponsible to imply that borrowing is always bad. If we borrow to invest, we increase jobs, stabilise the economy and increase tax revenues. That is good for the economy, not bad for it…... If we are investing in jobs, that gets taxes going back into the Revenue, which is good for the economy.” And, “The Chancellor is deliberately misleading the public by continuing to claim that all borrowing is irresponsible. It is not. What is irresponsible is failing to borrow to invest, providing we are able to sustainably meet the cost of borrowing.”

Jonathan Reynolds, describing the Charter as intellectually moronic said, “It essentially commits this House to never borrowing to invest, even when the cost-benefit analysis of that investment is such that the country would benefit greatly. That is why it has not one serious economist backing it.”

Helen Goodman said, “One of the most pernicious things about the rule that the Chancellor has chosen is that it treats capital and current spending the same. He is ignoring the fact that investing in housing, science, broadband, transport and the university system is a way of strengthening economic productivity and increasing growth in the British economy. Nobody thinks that it is right to max out the credit card to pay the weekly grocery bill—of course not—but families up and down this country take out mortgages to buy their homes. There is a precise parallel here.”

Regarding what John McDonnell himself said, as much of the press will not report it accurately, here are some of his key points “The worst false economy is the failure to invest. This will be a direct result of Government policy embedded in this charter, with its limits on all public sector borrowing. This Chancellor’s strategy has given us investment as a share of GDP lower than all the other G7 countries, falling even further behind the G7 average in recent years. It is incomprehensible for the Chancellor to rule out the Government playing a role in building our future. For him to constrain himself from doing so in the future, no matter what the business case for a project, has no basis in economic theory or experience.”

And, “We will not tackle the deficit on the backs of middle and low earners, and especially not on the backs of the poorest in our society. We will tackle the deficit, but we will do it fairly and to a timescale that does not jeopardise sustainable growth in our economy. We will balance day-to-day spending and invest for future growth, so that the debt to GDP ratio falls, paying down our debts”.

“That is why we will establish a National Investment Bank to invest in innovation across the entire supply chain, from the infrastructure we need to the applied research and early stage financing of companies. To tackle the growing skills shortages we will prioritise education in schools and universities along with a clear strategy for construction, manufacturing, and engineering skills to build and maintain sustainable economic growth. The proceeds of that growth will reach all sections of our society.”

Outside the Chamber, Chi Onwurah had previously written a strong piece deriding Osbornomics’ refusal to invest, “The Osbornomic farmer wouldn’t borrow to buy a tractor unless crop prices were falling. The Osbornomic househunter would not take out a mortgage unless her salary was being cut. The Osbornomic CEO would only invest in a new product line when revenues were falling.”

Long-standing Corbyn/McDonnell ally Diane Abbott made a series of similar points on Twitter, “Osborne's Fiscal Responsibility Charter effectively outlaws the equivalent of taking out a mortgage…..Osborne's Fiscal Responsibility Charter is a con-trick from a charlatan. Outlawing borrowing for investment means long-term stagnation….Every household and firm knows that borrowing for investment boosts incomes. Only Osborne and the austerity fanatics are unaware of this.”

These analogies are extremely useful for popularising the alternative to austerity, which is investment. The new leadership team has shown it can command an overwhelming majority in PLP with clear opposition to Tory austerity. Developing a broader understanding of the distinction between borrowing for investment and borrowing for consumption, and why Labour should support the former will be key in pushing back the Tories in the period ahead.

Tuesday, 13 October 2015

An earlier article ‘Why John McDonnell is correct to borrow for investment – an elementary economics lesson for Osborne’ analysed in the ‘family’ and ‘common sense’ vocabulary Osborne likes to present the distinction between state borrowing for investment and state borrowing for current expenditure – a key economic distinction Osborne’s Fiscal Charter deliberately tries to obscure. It also showed how sections of the media deliberately attempt to aid Osborne in this by talking of budget ‘deficits’ and ‘borrowing’ without distinguishing between borrowing for investment and borrowing for consumption.

The following article, an excerpt from a longer analysis of Western responses to the Great Recession, analyses the issue in more formal economic terms. It shows that John McDonnell is very far from being an ‘extremist radical’ in supporting state borrowing for investment. Among those holding the same logical position are fellow 'extremists' Ben Bernanke. Larry Summer and Martin Wolf!

* * *

An answer that may be immediately rejected in explaining the failure of response to the Great Recession, and the ‘new mediocre’ slow economic growth following it, was that no Western expert understood the situation. To the contrary, eminent Western economic figures well understood that the problem in the US and other Western economies was that the mechanism translating company income into investment was not functioning adequately, and that the solution was for the state to step in and invest these funds - as in Roosevelt’s 1930s response to the Great Depression. Merely a representative few of those arguing for this response will therefore be quoted - to show the accurate, indeed comprehensive, character of their analyses.

Ben Bernanke, almost immediately he could speak openly after ceasing to be Chair of the US Federal Reserve, called for:

‘a well-structured program of public infrastructure development, which would support growth in the near term by creating jobs and in the longer term by making our economy more productive.’1
Lawrence Summers, former US Treasury Secretary, argued:

‘We may… be in a period of ‘secular stagnation’ in which sluggish growth and output, and employment levels well below potential, might coincide for some time to come with problematically low real interest rates…

‘The… approach… that holds most promise – is a commitment to raising the level of demand at any given level of interest rates… This means ending the disastrous trend towards ever less government spending and employment each year – and taking advantage of the current period of economic slack to renew and build up our infrastructure. If the government had invested more over the past five years, our debt burden relative to our incomes would be lower: allowing slackening in the economy has hurt its potential in the long run.’2
Martin Wolf, chief economics commentator of the Financial Times, and one of the world’s most influential economic journalists, argued:

'In brief, the world economy has been generating more savings than businesses wish to use, even at very low interest rates. This is true not just in the US, but also in most significant high-income economies.

‘The glut of savings, then, has become a constraint on current demand. But since it is connected to weak investment, it also implies slow growth of prospective supply…

‘So what is to be done? One response to an excess of desired savings over investment would be even more negative real rates of interest. That is why some economists have argued for higher inflation. But that would be hard to achieve, even if it were politically acceptable….

‘Yet another possibility… supported by many economists (including myself), is to use today’s glut of savings to finance a surge in public investment.

‘The best response… is measures aimed at raising productive private and public investment. Yes, mistakes will be made. But it will be better to risk mistakes than accept the costs of an impoverished future.’3
Wolf analysed this situation in the UK, which faced the same problem as the US, citing similar views by other influential commentators:

‘With real interest rates close to zero… it is impossible to believe that the government cannot find investments to make itself, or investments it can make with the private sector, or private investments whose tail risks it can insure that do not earn more than the real cost of funds. If that were not true, the UK would be finished. Not only the economy, but the government itself is virtually certain to be better off if it undertook such investments and if it were to do its accounting in a rational way…

‘This does not even deserve the label primitive. It is simply ridiculous.’

Wolf clearly pointed to the consequences:

‘The results… are not at all ridiculous. They are extremely costly to both the economy and society. Yet, instead of taking advantage of the opportunity of a lifetime to repair and upgrade the capital stock, as Mr Portes [of the UK National Institute for Economic and Social Research] notes: “Public sector net investment – spending on building roads, schools and hospitals – has been cut by about half over the past three years, and will be cut even further over the next two.”’

Wolf concluded, endorsing such analysis:

‘He [Portes] recommends a £30bn investment programme (about 2 per cent of GDP). I would go for far more. Note that the impact on the government’s debt stock would be trivial even if it brought no longer-term gains…

‘the government… is refusing to take advantage of the borrowing opportunities of a lifetime…. It is determined to persist with its course, regardless of the unexpectedly adverse changes in the external environment. The result is likely to be a permanent reduction in the output of the UK.’ 4
Richard Yamarone, of Bloomberg Economics Brief, caustically noted:

‘Instead of adopting an economic solution such as matching idled and unemployed agents (millions of manufacturing and construction workers) with necessary improvements to the electrical grid, dilapidated highways, high-speed trains, outdated bridges, tunnels, ports, and water pipes, America received the political response of extended unemployment benefits and a whopping food stamp programme – safety nets for those who have fallen, not ‘stimulative’ measures.

‘Unlike during the Great Depression, which left a dazzling infrastructure legacy including a swath of bridges, tunnels, highways, art, dams and power generation, the only remnant from the 2007-09 depression is an underemployed labour force, earning a fraction of previous incomes, diminished skill sets and little or no promise for recent college graduates.’5References

If Osborne’s Charter for Budget Responsibility, which seeks to ban all government borrowing over the business cycle, was read naively you would assume it was written by an economic ignoramus who does not understand the difference between investment and current expenditure. But of course its economic howlers do not flow from ignorance but from a deliberate attempt to obscure issues which is driven by an ideological agenda to prevent the effective way for the economy to grow – by the state investing when the private sector does not.

In this deliberate attempt to obscure elementary economic realities Osborne is aided by sections of the media, such as the @bbcnickrobinson or @JohnRentoul, who equally talk about the budget ‘deficit’ without distinguishing between investment and current expenditure – although in their cases pure economic ignorance cannot be ruled out. However as other journalists such as @afneil (Andrew Neil) are capable of perfectly correctly understanding and expressing the issue, whatever their differences on other questions, it is more likely that some media comment follows Osborne’s deliberate attempts at confusion. As Osborne claims to explain things in homely ‘family terms,’ and as 'common sense,' we will do so equally – a second article will give a more formal economic statement related to present economic conditions.

The nation’s credit card and the nation’s house purchase mortgage

Virtually every family in the country in fact understands the difference between borrowing for investment and borrowing for current expenditure because that it how they organise their finances. To take Osborne’s analogy of the ‘credit card’ anyone who simply continues to run up debts to buy groceries on their credit card (current expenditure) without being concerned about whether they can repay them is heading for financial trouble. But no rational person decides to buy a house (investment) by first saving up the money and then buying the house – they take out a mortgage to do so.

This difference is even expressed formally in a balance sheet. If money is spent on food or other current expenditure there is an expenditure item and no corresponding asset – the expenditure has just been consumed, both literally and in economic terms. But the expenditure on the house has a corresponding asset – the house. This is a reason the borrowing for the house is entirely rational while ever increasing borrowing for current expenditure is not.

Osborne’s ‘Charter for Fiscal Responsibility’ is an attempt not only to limit expenditure on the credit card but to make it illegal to take out a mortgage to buy a house.

How factory machinery is financed

Another analogy, in this case from business, makes the situation equally clear. A company does not finance purchase of machinery, for example to build cars, out of its cash flow. It borrows the money, buys the machinery, and then repays the loan from the production. If it did not do so, and waited until it had saved the money for the machinery from current cash flow, that company would be totally outcompeted by companies which had borrowed the money, purchased the machinery, could now produce more efficiently, and had therefore gained a competitive advantage. That is why borrowing for investment is not merely economically rational but necessary.

George Osborne tries to obscure these elementary economic truths for his ideological purposes – he prefers the economy not to grow rapidly, and people to be poorer, unless it is done by the private sector. Sections of the media, by talking about the ‘budget deficit’ and borrowing without distinguishing between investment and current expenditure either are economically illiterate or themselves attempt to deliberately obscure elementary economic realities.

John McDonnell’s position has so far been correct. There is a clear economic difference between consumption and investment. The government should not borrow for consumption over the course of the business cycle. The government should borrow for investment. Osborne’s ‘Charter for Budget Responsibility’ should be amended to allow borrowing for investment. If it is not permitted to amend it, the Charter should be voted against. That has become Labour’s position and it is the correct one.

Wednesday, 7 October 2015

By Michael Burke Economics of budget deficits The debate is continuing on the purpose of government borrowing and the role of ‘balanced budgets’ - which was started by John McDonnell’s position of balancing the budget on current expenditure but borrowing for investment. This is not surprising given that economic policy has to be the core of the programme for a Labour government.

A thoughtful addition to the debate is this piece by Jo Michell in the Guardian, who asks for a real alternative to Osborne, which SEB has provided in relation to the Fiscal Responsibility Act. But an important misunderstanding should be clarified. That article argues that advocacy of a balanced current budget over the business cycle would be to 'emulate Ed Balls and austerity lite.' That is incorrect. It would only be the case if the level of government investment were maintained at current miserably low levels. Instead what is proposed here is a transformational increase in public investment, sufficient to foster a sustained recovery led by public investment. Far from this being ‘austerity lite’ it makes state driven investment a key to economic policy – entirely unlike the policy of Ed Balls.

The piece below examines this attachment to persistent government budget deficits, which have been combined with a simultaneous long-run decline in public investment.

The position on Osborne’s proposals that a Labour government should balance the budget on current expenditure over the business cycle but borrow for investment is set out in an earlier article here. It follows from the fact that the purpose of economic policy is, or should be, to optimise the growth in the sustainable living standards of the population. Increasing living standards requires growth – internationally over 80% of increases in consumption are due to economic growth. Since it is not possible to increase the fundamental productive capacity of the economy without investment, investment is the decisive factor in producing growth (in an overall framework of increasing the division/socialisation of labour). Therefore economic policy, including fiscal policy, should aim at increasing investment and gradually enhancing the proportion of output devoted to investment. This is the precondition for more rapid growth – ‘growing the economy out of the crisis’ as John McDonnell and Jeremy Corbyn put it. Borrowing should primarily be confined to investment, only resorting to support consumption in specific exceptional circumstances – such as to maintain living standards of the least well off sections of the population during economic downturns. Social protection should be financed via taxation – levied in a disproportionate way on the richer sections of the population.

However, permanent or structural budget deficits have become a shibboleth for many ‘Keynesians’. This has almost nothing to do with Keynes, who himself responded to critics by arguing that the General Theory was primarily focused on the ‘regulation of the investment function’ (and barely mentioned budget deficits)*. Instead, the attachment to budget deficits is a product of the post-World War II economic consensus. In Britain this was known as Butskellism, the Tory/Labour bipartisan approach to policy which ended in spectacular economic failure by the early 1970s.

This consensus failed because it was based on a myth. The reality is that at the beginning of ‘Butskellism’ Britain and the US had experienced war-related booms. In four years of World War II the US economy doubled in real terms, and was to take another 22 years before it doubled again. In Britain the economy expanded by 55% in 10 years to 1943 and it was to take another 25 years before it increased by another 55%.

The false economic consensus was that the ‘post-WWII boom’, which some even dubbed the Golden Age of capitalism simply required expert ‘demand management’, where every sign of downturn was met with more government borrowing to finance day-to-day spending (and government-run industries were starved of investment). The true position is that this was the dwindling of the war boom, when government investment and direction of the dominant sectors of the economy had predominated. The attachment to persistent or structural budget deficits, on current expenditure and not for investment, arises from this post-WWII economic failure. The success was state-led and directed investment of the war and war preparation years.

It is a rather strange feature of the debate that many ‘Keynesians’ also regard themselves as scourges of the finance sector in general and its dominance in British society in particular. Yet as both Adam Smith and Karl Marx noted, the material power of the finance sector derives largely from its parasitic relationship to government. The interest which fattens the finance sector comes significantly in the first instance from the government, and the taxes it levies on the productive economy. As for Keynes, it is the opposite of his ‘euthanasia of the rentier’, to continually hand state assets to the finance sector. When, briefly, the Thatcher and Blair governments each had budget surpluses, there were howls of protest form the City about the ‘death of the gilts market’.

If there are deficits on current expenditure, including all the very valuable functions that can or should be performed by government, these should be met with progressive taxation. As the burden of taxation has shifted from big business and the rich to workers and the poor over time, it is clearly imperative that the former should bear the burden of increased taxation. In just one example, Thatcher inherited a Corporation Tax rate of 60% and Osborne will bequeath a rate of 18%. That trend should be reversed. To the argument that this undermines private sector investment, this has been in sharp decline even as taxes have been cut (Fig.1 below, which originally appeared on the PWC website).

Fig.1 Investment as a proportion of GDP

The British economy is participating in an investment crisis of the Western economies. It also has its own structural investment crisis, as the chart above shows. It is this twin problem that Corbynomics can address, and so raise living standards through growth led by investment – including the creation of a National Investment Bank.

There is strong opposition to this policy from capital. If the state increases its rate of investment, necessarily a greater proportion of the means of production will accumulate in state hands not those of the private sector. The entire Reagan/Thatcher era was designed to do the opposite and we are still living in that era. Attempting to accelerate the gradual run-down of the role of the state in the productive economy their programme was to attempt to remove it altogether – the policy Osborne is continuing.

But we should be clear the advocates of the ‘small state’ confine this to investment – because it means an interference in the means of production. They have had far less difficulty, and in many cases no difficulty, in increasing Government consumption as Fig.2 below shows. The Thatcherites were really primarily advocates of ‘small state investment’.

Fig.2 US Government consumption rises as Government investment falls

Osborne seems set on turning that into ‘no state investment’. But this curtailing of state investment is directly counterposed to the needs of the great majority of the population. This is why Labour, by setting out the goal of growth created by investment, including creation of an National Investment Bank, aligns its policy with that of the population. By taking the position of a balanced budget over the cycle on current expenditure but borrowing for investment John McDonnell has adopted the correct position in terms of economic theory and simultaneously, and for that reason, restores public credibility to Labour’s economic policy.

By setting out clearly that the there is an alternative to Tory policies, and that the opposite of austerity is investment, the Labour leadership team can demonstrate that its policies are superior and can deliver prosperity for the overwhelming majority.

Friday, 2 October 2015

Jeremy Corbyn and John McDonnell are frequently in advance of many of their
supporters on economic matters, including their supporters in academia and economic
commentators. They are correct to argue against permanent budget deficits and
in favour of the central role of public investment as the path out of the
crisis, identify People’s Quantitative Easing as a useful policy tool, and to
question the ‘independence’ of the Bank of England. They have faced unwarranted
and confused criticism on all of these from some on ‘the left’.

The recent indicators point to a slower pace of economic activity and the Tory
government is about to embark on Austerity Mark II, in nominal terms exactly
the same level of cuts and tax increases as the £37 billion George Osborne
announced in 2010. As the Tories have little popularity (the second lowest
popular share of the vote for any government) it has been necessary for this
project that there is a pretence that this not a return to austerity, after the
boost to consumption that helped the Tories get re-elected. So, there was the
fiction that recently there was a ‘One Nation’ Tory Budget, that Osborne was
‘stealing Labour’s ideas’ and similar nonsense.

Politically it is crucial for the Tories that there is no opposition to the latest version of cuts, as this would show the blantant falsity of the claim that the Tories have a
commanding parliamentary majority and that There Is No Alternative. This
necessity explains why the other Labour leadership candidates were so wrong to
give the Tories a free pass on welfare cuts.

However the election of Jeremy Corbyn and the appointment of John McDonnell as
Shadow Chancellor changes the previous situation in which Labour did not in
fact challenge the Tories' central economic policies. Now the Tory tactic is to
set a series of political traps for the new team in the hope of detaching them
from either, or both, the majority of the population or their base of
supporters. This is taking place primarily on the area of foreign affairs and
the military. But on the economic front this will be the introduction of an
amendment to the Fiscal Responsibility Act. This proposed Act precludes borrowing in normal
circumstances/over the course of the cycle not only for current government
expenditure but also for investment. It also commits future governments
to run budget surpluses when the economy is growing, to be overseen by the
Office for Budget Responsibility.

Labour’s response

Initially, George Osborne hoped that by announcing the new law and holding it
over to the autumn that it would dominate the Labour leadership campaign. That has
failed spectacularly. Instead it is possible to turn the tables on Osborne and
use the debate and vote to set out clear differences with him.

To achieve this it is necessary to approach these questions soberly and
intelligently. To paraphrase a remark by Trotsky, the appropriate economic policy is not at all automatically
derived from the policies of George Osborne, simply bearing only the opposite sign
to him – this would make every madcap pundit an economics guru. It is necessary
for Labour to put forward a positive economic policy based on a correct
economic theory.

Labour should formulate its own policy and pose that sharply in contrast
Osborne’s. It must be based on a clear understanding of the difference between
consumption and investment. Investment is the chief motor of economic growth,
with the latter in turn being the chief determinant of the population’s living standard.
Therefore the way to ‘grow the economy out of the crisis’, as Jeremy Corbyn and
John McDonnell have correctly put it, is to increase the economy’s level of
investment. As the private sector has failed to do this the state should step
in. This should be expressed in a policy to increase state investment, and to
create National Investment Bank – which should finance both state and private
investment.

The key question is where the savings equivalent to such investment should come
from, and this in turn relates to the current expenditure in the budget. Current
expenditure can be financed in one of two fundamental says. It can be financed
by borrowing, but in that case this reduces the proportion of the economy
devoted to savings/investment, which is undesirable as it will slow economic
growth and therefore the increase in living standards. Or consumption can be
financed by taxation, in which case it merely means privately financed
consumption is being replaced by government financed consumption (either
government final expenditure or transfer payments) in which case the level of
investment is not being reduced and growth will not be reduced.

It therefore follows that for a coherent and sustainable policy current
government expenditure should be financed out of taxation, in particular on
higher incomes and luxury consumption, and not out of borrowing.

Expressed in terms of budget deficits and borrowing his means that the aim should
be for a balanced current budget over the business cycle, but reserving the
right to borrow for state investment. This is the correct position expressed by
John McDonnell. This therefore means that an amendment to Osborne’s Bill
expressing that position, of no deficit over the cycle for current expenditure but permitting borrowing for investment, should be moved by Labour. This will establish its
position clearly.

But, in the likelihood an amendment of this type were to fall, although some
other parties may vote for it, then Labour should vote against the entire bill
– as it excludes borrowing for investment. (In fact the level of state
borrowing for investment currently should be considerable, up approximately 3-5%
of GDP). Labour should explain its position of voting against the bill as a
whole because of the defeat of its amendment.

In this way, Labour’s approach would be very clear. It is not in favour of
public borrowing to fund current expenditure and is in favour of borrowing to fund investment. As a balanced budget law does not allow that
investment, Labour would be opposed to the Tory policy.

Labour should not support the Bill without this amendment as this would
preclude borrowing to invest and leave the economy at the mercy of a private
sector which has achieved only chronic under-investment. Neither should it
simply oppose the Bill without offering an alternative, especially not on the
spurious grounds that any public sector surplus should be ruled out because it
‘obliges the private sector to run a deficit’. Sometimes the private sector, or
at least the business component should be obliged to run down its savings, if
it is hoarding cash and refusing to invest. Many countries accumulate budget
surpluses in their sovereign wealth funds, to be used for investment at a later
date. This is what should have occurred with the windfall of North Sea oil,
rather than wasting it on consumption in the ‘Lawson Boom.’

In taking a clearly different approach,
Labour's new leadership will be able to demonstrate it has an entirely
different policy to the Tories based on increasing investment to increase
prosperity.

The debate
relates to fundamental issues of economics and economic policy. It leads to what
policy framework a radical, anti-austerity party (or government) should adopt.
In the course of a constructive debate we should aim to arrive at some greater
clarity on this important issue.

The
debate

The original
SEB piece began with the argument that the main factor accounting for growth is
investment. This has long been the position in classical economics from Adam
Smith, who called it an ‘increase in stock’, to Marx, who used the term
‘development of the productive forces’. Keynes pointed out that the ‘General
Theory’ was primarily concerned with how to regulate the investment function in
order to achieve growth and prevent slumps*. Modern usage speaks of an ‘increase
in productive capacity’. However, the
logic of this classic position has now been demonstrated by the highest point of
modern econometric analysis, most especially through Vu Minh Khuong’s masterly
study The Dynamics of Economic Growth .

All output
requires inputs. Consumption is not an input and therefore cannot lead economic
growth. All economic activity depends first on production (of a good or
service).It is not possible to consume
that which does not already exist, either through nature’s abundance, or through
the production process.

The decisive
inputs for output are the level of fixed investment and the amount and quality
of labour. Vu Minh Khuong’s study shows that, taken together these account for
about 90% of all growth in the advanced industrialised countries, with fixed
investment playing the predominant role (57% of all growth in the advanced
economies).

Consumption
cannot logically be input to growth. Consumption takes place only after the
production process is complete, and is highly dependent for its own growth on
the growth of output. It has a dependent, subordinate role in relation to
output.

There are
also only two ultimate destinations for output. It can either be consumed or
invested. Since investment is the sole factor of these two which can raise the
level of output, it follows that the greater proportion of output devoted to
investment, the greater the potential growth of that output. The opposite also
applies. The greater proportion of output devoted to consumption, the lower the
potential growth of output. There is no such thing as ‘consumption-led growth’
(or its near cousin, ‘wage-led growth’ as wages too are a consequence of output,
and the struggle between classes over its distribution).

A farmer’s
crop in one year is ten bags of wheat. If she and her family consume all ten
bags, there is no seed to sow for next year’s harvest. If she retains two bags
to sow next year the crop will be the same. But if she can reserve 3 bags to so
next year the crop will be 50% bigger, all other things being equal. By
increasing the proportion of output devoted to investment, total output rises in
the following year and so can the level of consumption. The increasing
complexity of economic activity does not alter these fundamental relationships
between investment, growth in output and consumption.

This relates
to the debate on balancing the budget. If a radical, anti-austerity government
simply borrows or creates money to fund consumption, it will provide no boost to
long-term growth. This is merely a stimulus to spending or consumption. This may
be needed when consumption has fallen dramatically but cannot be a feature of a
medium-term economic policy. If on the
other hand, the same government borrows to invest in the productive capacity of
the economy then the economy is capable of sustainable expansion. This in turn can lead to economic growth and
the growth in consumption. Therefore such a government or economic policy
framework, which we can call Corbynomics, should aim at increasing the level of
borrowing for investment and aim at eliminating borrowing for consumption in
favour of borrowing for investment.

Unfortunately, the PRIME piece
does not deal with this substance of the original argument. Instead, there is
agreement that there is only consumption or investment, and no logically
separate category of ‘government’. It agrees on the need for public
investment.It also agrees that there
can be money creation to fund public spending.

But it is
hopelessly confused in treating the central argument. This is that there is only
consumption or investment, and of these two only the latter can contribute to
growth. Instead, it accuses the original piece of containing:

‘the
classical economists’ error of assuming there is a fixed amount of money which
if used for purpose (a) cannot be used for purpose (b)’.

This is false
and somewhat foolish. Consumption and investment are different functions.
‘Money’ or more accurately output, cannot be used for both functions
simultaneously.Money is a medium of
exchange used to purchase a good or service, and this can only be for
consumption or investment. (Money as capital can also be, and frequently is
hoarded. This is the situation currently and which is why the state must lead an
investment recovery.) Furthermore, the proportions between consumption and
investment are decisive for growth.

If Nominal
GDP (Y ) is 100, and Consumption(C) is
85 and Investment (I) is 15.

The ratio
between the two is approximately 5.5 : 1 (This is the position in the US economy
currently. In the British economy it is close to 6.5 : 1).

If Y remains
at 100 but C is increased to 90, then I must fall to 10. Contrary to the
assertion of the PRIME article the two must sum to 100. But the ratio between
them has adversely altered in terms of subsequent growth.

The PRIME
piece may be confused between proportions and levels. This is not clear but is
implied in the digression on the desirability of public services such as the
NHS, education and so on.Neither SEB
nor, more importantly, John McDonnell favours cuts to spending in these areas,
indeed both would seek to raise them. But the PRIME piece seems to suggest that
this is what is stake in the debate and this is a confusion of its own.

To clear up
this confusion: C cannot add to Y. This is because, if C = Y, then I must equal
zero. As a consequence Y cannot grow. Nor can C grow, because it is based on Y
and follows it. But if Y is 100 and C is 75 and I is 25, then the ratio between
the two changes from 4.5 or 5 to 3. And, all other things being equal the growth in Y will increase in following
years by approximately 2%, from which it would be possible to increase C and
I.

No-one in
this debate wants government spending on public goods and services to decline,
or the pay that is necessary to provide them nor the entitlements to social
protection. That is the austerity policy.

But it is
only possible to launch a sustainable increase in public services if there is
economic growth, and this depends on investment. The principal policy aim should
instead be aimed at driving up I at the optimal sustainable rate. This is the
main factor (along with improving the quality of labour via education and
training) which can lead to a rise in average living standards. Therefore the
requirement to increase I is the basis for all serious discussion on People’s
QE, government borrowing, taxation, wasteful spending such as Trident, and so
on. The determining role of investment
in creating growth and prosperity explains the role and importance of borrowing
to invest.

It is not
possible to shop your way to riches. Neither is it possible to borrow your way
to fund consumption. This is effectively what has been encouraged in the Western
economies over a prolonged period. It has led to economic slump and stagnation.

As for the
current budget deficit, this was £66 billion in 2014 while the revenue form
Corporation Tax was £42 billion. It would be possible, for example, to have a
graduated rise in this tax rate alone to halve the current budget, while still
leaving the rate below that of the US, Germany, Japan and other industrialised
countries.

But the main
driver of the decline in the current budget would be growth itself, which, as
the PRIME piece agrees, would generate tax revenues and lower government
outlays. The disagreement lies in identifying how that growth is to be
generated.